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When ESG investing was first touted at the beginning of the turn of the millennium, investors were hesitant. Their focus was shareholder value, not environmental and social or corporate governance.
Some 15 years later the value of global assets under management at funds applying environmental, social and governance (ESG) criteria stood at $40.5 trillion at the end of 2020 – telling the extraordinary growth story of a market that has almost doubled over the past four years and more than tripled over the last eight years.
In this article, we take a closer look at the evolution of ESG investing.
GSIA: The Global Sustainable Investment Alliance, a collaboration of membership-based sustainable investment organizations around the world, aims to deepen the impact and visibility of sustainable investment organizations at the global level.
UN PRI: The UN PRI organisation is the world’s leading proponent of responsible investment. It helps the investor community to understand the investment implications of environmental, social and governance (ESG) factors and supports its international network of investor signatories in incorporating these factors into their investment and ownership decisions.
CFA Institute: The CFA Institute is a membership-based organisation for the investment profession. It promotes the highest standards of ethics, education and professional excellence in the investment profession for the ultimate benefit of society.
IA: The Investment Association is the trade body and industry voice for the UK’s leading investment managers.
Pensions Climate Risk Industry Group: The group, established in 2020, has recently produced draft, non-statutory guidance on assessing, managing and reporting climate-related risks in line with the Taskforce on Climate-Related Financial Disclosures.
A brief history of sustainable investing and how it evolved
The idea for investors and corporates to act in a socially responsible manner has a long history, dating back over 3500 years when the major world religions already advocated ethical investing in their main writings.
In the 17th century, socially responsible investing (SRI) came to the forefront with the Quakers casting out companies that profited from slavery or war. Religious groups followed in the early 1900s, urging people to steer clear of investing in companies linked to gambling or selling alcohol as well as lenders that charged excessive interest. The first SRI fund was launched in 1928 (Pioneer Fund) and used exclusionary screens based on social issues.
Equally, evidence of businesses’ concern for society, today known as Corporate Social Responsibility (CSR), can be traced back to the Industrial Revolution. In the mid-to-late 1800s, growing criticisms of the emerging factory system, working conditions, and the employment of women and children were brought to light. The consensus among reformers was that unfair employment practices were contributing to social problems, including poverty and labour unrest.
The late 1800s also saw the rise of philanthropy. Industrialist Andrew Carnegie, who made most of his fortune in the steel industry, was known for donating large portions of his wealth to causes related to education and scientific research. In 1953, American economist Howard Bowen introduced the modern concept of Corporate Social Responsibility in his book “Social Responsibilities of the Businessman”, which advocated for business ethics and responsiveness to societal stakeholders.
Press forward from the 1960’s to 2020: With the value of sustainable assets under management totalling $40.5 trillion at the end of 2020, sustainable investing is entering mainstream. In the first half of 2020, the PRI saw a 28% increase of signatories to more than 3000 members of the global investment community, while flows into sustainable funds globally reached a record $45.7 billion during the first quarter of 2020, driven by investors seeking out sustainable, resilient business models in the wake of the COVID-19 pandemic. Meanwhile, in the same period, the overall fund universe suffered $384.7 billion in outflows.
Sustainable investing and sustainable investors come in different shapes and forms
There is no single approach to sustainable investing. Investors have different motivations and hence will approach sustainable investing from different angles: for some it might be the desire to help disadvantaged communities to thrive that guides their search for investment opportunities, while for others advancing the transition of a low-carbon society might be their sole investment focus. Consequently, there’s no single term for sustainable investing. Depending on the emphasis of what investors want to achieve, labels such as “community investing,” “ethical investing,” “green investing,” “impact investing,” “mission-related investing” and many more coexist in the sustainable investing universe.
Likewise, sustainable investors aren’t one homogenous group, but represent our diverse society. Sustainable investors comprise individuals, including average retail investors to very high net worth individuals and family offices, as well as institutions, such as universities, foundations, pension funds, nonprofit organizations and religious institutions. Within those groups, investors are driven by different personal values and beliefs, different goals, and they’re differing in their degrees of ESG prioritisation.
Our following chart, using fixed income investors as an example, shows in more detail how sustainability intensity could vary:
Fixed income investor sustainability strategies
Sustainable investing – how to separate the wheat from the chaff
While a diverse and still developing market, a number of sustainable investment strategies have emerged over the years, which are now considered good standard for seeking out the most impactful as well as financially successful investment opportunities. They differ in their approach on how ESG factors are applied, and they have differing levels of engagement with the ‘investment targets’.
The most prominent methods include:
- Negative/exclusionary screening: relates to excluding companies or sectors as potential investment targets due to falling short of expected ESG standards.
- Positive screening: involves the investment in sectors, companies or projects based on their positive ESG performance relative to industry peers.
- Norms-based screening: is a sub-category of negative screening, whereby potential investment opportunities are declined on account that they fail to meet internationally accepted ‘norms’ such as for example the UN’s SDGs, the Paris Agreement, the UN Global Compact principles or UN Declaration of Human Rights.
- ESG Integration: the systematic and explicit inclusion by investment managers of environmental, social and governance factors into financial analysis.
- Sustainability themed investing: investment in themes or assets specifically related to sustainability (for example clean energy, green technology or sustainable agriculture).
- Impact/community investing: targeted investments aimed at solving social or environmental problems, and including community investing, where capital is specifically directed to traditionally underserved individuals or communities, as well as financing that is provided to businesses with a clear social or environmental purpose; and
- Corporate engagement and shareholder action: corporate engagement refers to investors encouraging companies through a process of research and dialogue to improve their social and/or environmental impact, while shareholder action can be more confrontational with investors using of shareholder power to influence corporate behavior, for example through filing or co-filing shareholder proposals and proxy voting that is guided by comprehensive ESG guidelines. 
In 2018, according to the biannual Global Sustainable Investment Review from the Global Sustainable Investment Alliance (GSIA), negative/exclusionary screening represented the largest sustainable investment strategy globally ($19.8 trillion), followed by ESG integration ($17.5 trillion) and corporate engagement/shareholder action ($9.8 trillion).
The regional picture, however, looked slightly different: In Europe, negative screening was the most applied strategy, ESG integration dominated in the United States, Canada, Australia and New Zealand, while Japanese investors favoured corporate engagement and shareholder action.
Sustainable investing – the varying popularity of E, S and G
While the E in ESG moved into the global spotlight in 2019, when Greta Thunberg became the face of “Fridays for Future”, demanding – together with other climate change activists such as “Extinction Rebellion” – immediate action to prevent the consequences of global warming and climate change, the shock and the dramatic consequences of the COVID-19 pandemic has thrown the S in ESG into sharp relief, reinvigorating the debate about corporate purpose: Do companies solely exist to maximise profits and shareholder value? Should they serve society in other ways than solely paying taxes? How do they care for their employees during such a crisis – are they willing/should they be willing to take on additional responsibilities to look after their staff?
Investors sentiment very much reflect the public sentiment: In a recent study 70% of 23,000 private investors surveyed globally said that a company’s impact on communities and society is ‘very important’ to them, and nearly the same number, 67%, said they expect companies to pay attention to environmental issues.
The G aspect of ESG often appears to fade into the background in the public coverage of ESG, but there’s consensus that good corporate governance is essential to yield corporate returns and that “E” and “S” don’t hold much without effective governance.
Research suggests that asset owners in the earlier stages of ESG adoption are more likely to have an initial focus on governance factors, but as investors grow in sophistication, environmental factors start to take precedence in their portfolios.
The varying emphasis on either E, S or G factors seems to also depend on the origin of the investors: while climate change and environmental sustainability are the focus of European and North American investors, asset owners in the Asia-Pacific (APAC) region rank corporate governance ahead of environmental sustainability – one reason being that APAC investors often have large exposures to emerging Asian markets where disclosure and corporate governance standards are generally less developed than in Europe and North America.
Meanwhile, investors across all regions face a dilemma with regards to social issues, which feature – as outlined earlier – as high as environmental factors. However, there’s a dearth of reliable metrics and viable investment products, but the public debate about corporate responsibilities during and post the COVID-19 pandemic, which resulted in a rise in social bonds issuance in 2020, has emphasised the need to more urgently develop solutions for the reporting of social impact.
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Read the further articles in this series: